COVID-19 has taught investors that they need to be prepared for a variety of economic scenarios. By thinking ahead and making risk analysis a part of your portfolio management, you can protect and control your investments during times of market volatility. To help you get started, we created a comprehensive playbook with actionable insights around portfolio optimization and portfolio stress-testing strategies.
- Stress-testing helps you spot vulnerabilities in your portfolio so you can optimize for different economic conditions.
- Refinitiv’s Eikon platform allows you to understand potential risks and increase your risk management capabilities.
- Portfolio optimization enables you to achieve maximum return for minimum risk.
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We live in times of extreme volatility and uncertainty. In order to optimize their holdings for economic recovery, asset managers must gain a deep understanding of their portfolio’s vulnerabilities.
Portfolio risk analytics can help you:
- Understand how different economic scenarios may impact your portfolio
- Tell a data-based investment story and reassure your clients
- Minimize risks and optimize your portfolio for maximum returns
Let’s take a look at some portfolio optimization and portfolio risk management tactics that all investors should implement.
Stress-testing your portfolio
Stress-testing means simulating potential future situations. This helps you to understand the weaknesses of a portfolio, minimize or mitigate risks, and ease your clients’ minds using data.
There are two main types of stress tests:
- Predictive stress tests
A predictive stress test involves envisioning a possible future state of the world and attempting to test those market conditions, analyzing how your portfolio may perform.
- Historical stress tests
A historical stress test is based on examining what happened in a certain period in the past and applying it to today’s portfolio and market conditions.
How to run portfolio stress tests
Any successful stress test must fully revalue assets using detailed pricing models. It’s best practice to use multi-asset class stress tests, and have a flexible approach to correlation assumptions.
Here are the four most important steps to running a successful portfolio stress test:
- Examine the portfolio and risk factors. Choose a limited number of risk factors (equity returns, spreads, rates, sector returns, etc) and uncover which of your assets are prone to underperforming.
- Design a scenario. Build a complete and consistent stress test by designing a scenario that considers market variables and shock amplitude. A good stress test scenario should be unambiguous and paradox-free.
- Stress test regularly. Perform periodic stress tests to spot early indications of changes in risk exposures. Quantify the exposure to various changes in future market conditions.
- Act on future market events. Build hedging strategies for the future market events that seem most likely.
Using Refinitiv’s Eikon platform for multi-factor stress testing
Today, there are powerful data solutions available that let you perform stress testing for portfolio optimization.
Using Refinitiv Eikon, you can explore areas of potential risk and increase your capacity to undertake risk management on your portfolio. The platform also allows you to leverage custom multi-factor stress testing and perform other key tasks such as performance monitoring.
The key elements of portfolio optimization
The aim of portfolio optimization is to deliver a portfolio that offers a maximum return for minimum risk. It helps you tailor your portfolio to specific investor needs, such as an increased focus on sustainability and higher ESG scores.
The key elements of portfolio optimization are:
- A universe: An index or a set of companies that share a commonality (for example, robust ESG practices). This universe is used to set the parameters for the portfolio.
- Factor model: Used to calculate the risk and influence of external and quality factors on the performance of the portfolio.
- Expected returns and other asset characteristics.
- Optimizer: A tool that uses factor modeling to produce an optimal portfolio (and a trade list) by modifying certain factors.
With portfolio optimization, it’s also possible to: Target ESG scores, minimize transaction costs, re-balance existing holdings, select a risk target using an efficient frontier, maximize fundamental ratios, or optimize across multiple accounts.
Watch: Stress-testing portfolios for economic weakness. Optimizing portfolios for economic recovery.
To learn more about optimization strategies, tune in our recent webinar hosted by Refinitiv and MSCI experts:
Watch — How to optimize your portfolio for economic recovery: Expert deep dive
How to find the optimal portfolio
Finding the optimal portfolio is complex and time-consuming. The Eikon-MSCI portfolio risk analytics tool can help you simplify the process by allowing you to:
- Set constraints for all Refinitiv data
- Input StarMine® stock selection factors and rankings
- Factor ESG into portfolio construction and optimization
- Use MSCI’s data within the whole suite of Portfolio
- Produce customized analytics reports
The Eikon-MSCI platform offers an agile and data-driven approach to portfolio analytics. Thanks to its powerful capabilities, it gives you the confidence to make the right investment decisions.
For more information on portfolio optimization, download the Ultimate Guide to Portfolio Risk Analytics: